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ESG fixed-income research: revealing what others may overlook

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      By Brian S. Ellis, CFA, Calvert Fixed Income Portfolio Manager and Vishal Khanduja, CFA, Calvert Fixed Income Portfolio Manager

      This is the third in a series of blogs based on Calvert's white paper: Responsible fixed-income investing: How Calvert delivers for asset owners.

      Boston - In our experience, integrating environmental, social, and governance (ESG) factors into traditional fundamental research is critical in evaluating an issuer's quality and can enhance investment performance and positive impact.

      The core premise is that companies must address a range of ESG factors that materially affect their industries. Thus, the picture of an issuer's long-term outlook is incomplete unless it reveals how these financially material factors are recognized and controlled by management.

      We believe the Calvert Research System differentiates us from many other ESG investment managers in its depth of coverage, focus on materiality, and inclusion of comprehensive, diverse data sets. Calvert's ESG research analyst team leads the research process in collaboration with the fixed-income and equity investment analysts to identify the most material ESG criteria and data indicators by subindustry.

      The data challenge

      In recent years, as interest in sustainable investing has soared, publicly reported ESG data has exploded. Only eight years ago, for example, just 20% of the S&P 500 provided any type of reporting on material ESG risks; 85% report on these risks today.1 A wide variety of information providers aggregate this information and assign their own assessments. This poses the challenge of an enormous amount of absolute data with a decreasing percentage of decision-useful information.

      A proprietary structural framework

      Calvert has addressed this by developing a customized scoring framework that ranks companies by subindustry — relative to their peers — using what we believe to be the best available information. Calvert ESG analysts further evaluate these scores, drawing upon their deep sustainability and sector expertise.

      Our ESG research process has three components:

      • Structural assessment: We rate and rank companies on their management and disclosure of ESG issues that are financially material to their operations. This is a longer-term assessment of management's intentionality to address material ESG risks.
      • Product impact factor: We evaluate whether the company has specific products, services or business practices that may have significant impact on the company itself, society, or the environment.
      • Circumstantial factors: We examine recent news about the company related to its involvement in adverse or controversial events and management's response. This is a shorter-term measure of a company's ESG risk management.

      Filling in the data gaps

      Often, traditional analyses can overlook telltale warning signs that may be flagged through an ESG focus, giving us the opportunity to adjust our portfolio as appropriate. Calvert's capabilities are especially critical for analyzing the large universe of issuers that lack fully available quantitative information. For example, while all investment-grade corporate issuers are assigned quantitative scores, just over half of high-yield corporate issuers are scored. Information is also scarce and/or uneven for private companies, smaller-capitalization companies, and other niche sectors like securitized bonds and bank loans.

      A focus on materiality

      Our focus on materiality ensures that our research efforts focus on factors that have the greatest financial and societal impact. Governance factors, for example, may have greater weight and relevance for financial firms, while environmental factors may play a bigger role for electrical utilities.

      Calvert's research framework integrates public and proprietary information, helping us achieve internal consistency even when data disclosure falls short. In the final analysis, this allows us to build an opportunity set that reflects an optimal combination of ESG, structural, technical, and credit analyses for careful security selection. We construct risk-adjusted portfolios in keeping with the team's top-down view.

      Bottom line: Calvert's ESG capabilities are especially critical for analyzing the large universe of issuers that do not have fully available quantitative information, including many high-yield, small-cap and private issuers.